Four companies that service 25 percent of outstanding subprime loans in California have agreed to streamline the loan modification process to allow some borrowers with adjustable-rate mortgages to avoid interest rate resets.

California Gov. Arnold Schwarzenegger said a voluntary agreement with Countrywide Financial Corp., GMAC Mortgage, Litton Loan Servicing and HomeEq Servicing is modeled after a proposal put forward by Federal Deposit Insurance Corporation chief Sheila Bair.

Bair, citing a report by Moody’s Investor Services that servicers were engaging in workouts on less than 1 percent of troubled subprime loans, last month urged them to embark on a program of wholesale conversions of adjustable-rate mortgages into fixed-rate loans when borrowers are in danger of default.

In an interview published in today’s Wall Street Journal, U.S. Treasury Secretary Henry Paulson said he expects a “significantly bigger” number of mortgage defaults in 2008, and said he is encouraging servicers to develop criteria that would enable large numbers of borrowers to qualify for better terms.

“We’re never going to be able to process the number of workouts and modifications that are going to be necessary doing it just sort of one-off,” Paulson told the Journal.

Schwarzenegger, who said 500,000 Californians with subprime loans face interest rate resets in the next two years, said loan modifications “can save tens of thousands of people from being added to the foreclosure lists” but “does not involve a government subsidy or bailout.”

California had the second-highest rate of foreclosure activity in the nation during the third quarter, second only to Nevada, according to data aggregator RealtyTrac Inc. Half of the 10 metropolitan areas with the highest rate of foreclosure activity during the third quarter were located in California, RealtyTrac said in another report.

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